Does a rebalance bonus exist?

[Pet Hog]

Inspired by a debate on another thread, I decided to sacrifice my afternoon and run the numbers from Peak2Trough's site to see if there is such a thing as a rebalance bonus in the PP with 35/15 rebalance bands.  Starting on January 1 of each year since 1972, I calculated the CAGRs for PPs (with dividends reinvested) with either 35/15 rebalance bands or without rebalancing at all.  Here is a chart showing the numbers (excluding 2013 and 2014, where no rebalancing has occurred):



Here is a chart of the "rebalance bonus" -- the difference between rebalancing or not:



In six of the years (1980–1983, 2006, and 2012), buy-and-hold was the preferred strategy.  In the other 35 years, however, this rebalancing strategy would have paid off (ignoring fees and taxes).  Overall, the average rebalancing bonus has been 0.53%.

Based on this analysis, I would recommend rebalancing to anyone investing in the PP (again, ignoring taxes and fees—or any "January 1" effect). 

[buddtholomew]

Thanks for the analysis. Is it possible to breakout by holding, e.g. Equities to Gold resulted in a re-balancing gain or Gold to LTT's, etc.?

[Pet Hog]

Thanks for the analysis. Is it possible to breakout by holding, e.g. Equities to Gold resulted in a re-balancing gain or Gold to LTT's, etc.?

I am sure it would be possible, but a bit tedious.  Taking the 1972 example, there have been 15 rebalances over 42 years — how easy would it be to decide ones were responsible for the rebalance bonus?  The simplest case is the 2012 example (where buy-and-hold wins).  The portfolio began on January 1, 2012, and was rebalanced on November 12, 2013, because stocks reached the 35% band:

Stocks 35.0%
LTTs 21.0%
Cash 24.1%
Gold 19.9%

Since then, the changes in the dollar amounts of the assets have been:

Stocks +9.8%
LTTs +11.9%
Cash 0.0%
Gold –1.3%

So the rebalance out of stocks and into bonds and gold wasn't worth it because "not stocks" went up by only 3.5% (average of +11.0, 0.0, and –1.3%), even though buying bonds was a great move.

A similar analysis could be done after each rebalance event for each distinct starting date.  Here's one more for the January 1, 2008, example (here, the rebalance bonus has been almost 2%).  There have been two rebalances:

November 19, 2008 (rebalance date was November 20; presumably stocks went down intraday to below 15%)
Stocks 15.5%
LTTs 30.8%
Cash 28.3%
Gold 25.3%

This rebalance was primarily from LTTs and cash into stocks.  The dollar-value changes from November 20, 2008, until the next rebalance day (April 27, 2011) were

Stocks +88.8%
LTTs –7.0%
Cash +0.6%
Gold +104.4%

So the components that were sold (LTTs, cash) went down by 3.2%, while the other two (stocks, gold) went up by 96.6%.  A huge bonus for rebalancing.  On April 27, 2011, the PP percentages were

Stocks 32.2%
LTTs 15.8%
Cash 17.1%
Gold 34.8%

The rebalance occurred the next day, April 28, 2011 (I don't know if it was LTTs going down or gold going up, but it doesn't matter).  Stocks and gold were sold; LTTs and cash were bought.  Since then, the following dollar-value changes have occurred:

Stocks +47.9%
LTTs +31.0%
Cash +0.4%
Gold –18.1%

So the things that were sold went up 14.9%, while the things that were bought went up 15.7%.  A slight victory for rebalancing, even though the component that went up the most was one that had been sold in the previous rebalance event.

[AdamA]

Keep in mind that, bonus or not, rebalancing greatly decreases portfolio volatility.

Craig wrote about this a while back, I think.

[Pet Hog]

Cool, Pet Hog!  Thanks for running the numbers.

Just so I'm clear, was each back test from January 1 in year X through... today?

That is correct.  Until today: May 30, 2013.  I should edit the charts and upload them again.  Thanks for spotting that!

[Pet Hog]

Keep in mind that, bonus or not, rebalancing greatly decreases portfolio volatility.

Craig wrote about this a while back, I think.

One of the main attractions of the Permanent Portfolio!

[annieB]

Keep in mind that, bonus or not, rebalancing greatly decreases portfolio volatility.

Craig wrote about this a while back, I think.

+1

Remembering how the 5% drawdown in 2013 freaked a bunch of us out.
Gotta rebalance...

[Kbg]

When contemplating the efficacy of rebalancing I believe it is critical to keep in mind the concept of path dependency. On any given event, we just do not know if it will be helpful. It depends on a future path we can't see when we do it. However, here is what we do know with certainty:

- taxes will be paid on profits
- a portion of these profits will be converted to cash

Here is what has a good probability of happening:

- volatility of the portfolio will be reduced
- profits are reinvested in underperforming assets
-- normally assets are mean reverting

HB assumed we can not know the future which led to the 25% allocation approach. Do you or do you not buy into this assumption? If you don't why are you invested in a PP?

Given all of the above, what are the implications for rebalancing?

- above all we should not rebalance without it being net beneficial AFTER taxes. If we assume unknown path dependency that would suggest we don't want to generate short term gains which are taxed at a higher rate.

- rebalancing should reduce volatility and will convert some profits to cash (safety)

- after the above it gets sketchy at best and we begin to refute the assumption of not knowing the future

[ns3]

All I know is that when I sold stock and bought gold back in January it was probably the first time in my life that I ever knowingly sold high and bought low and I felt good about it. At that point I resolved to not look at my portfolio again until next January because I don't want to know whether or not I could have sold higher and bought lower. And that's about the same way I feel about backtesting to see if a rebalance bonus exists. As long as the PP is doing what I want it to, giving me a decent return with low volatility, I don't care.

[stuper1]

I'd be interested to see the same analysis done with the 40/10 rebalance bands available on PeaktoTrough.com.  I'm guessing it would show an even bigger rebalance bonus.  If I get time I'll run it myself.